Uncle Sam Changes Financial Aid Rules

The budgetary imbalance addressed by the Deficit Reduction Act of 2005 (signed into law in 2006) is, of course, the government’s. But if paying college bills is in your future, this legislation could affect your family’s budget, too. Changes made it easier for some students to qualify for financial aid. And if you or your kids borrow money to cover educational costs, you will save on loan origination fees and could ultimately benefit from a shift from fixed to variable interest rates.

New treatment of custodial accounts. The current federal financial aid formula makes a sharp distinction between student and parental assets. Students who have money held in their name in a custodial account—a UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfer to Minors Act)—are expected to contribute 35% of the value of the account each year. So if your daughter has $100,000 in a UGMA, the aid formula’s “expected family contribution” will include $35,000 from the account. Parental assets, on the other hand, including funds held in a 529 plan established for a student, are assessed at only 5.64%. UGMA assets moved into a “custodial” 529 plan are also considered a parental asset, according to Joe Hurley, founder of Savingforcollege.com. But one custodial account drawback will remain after the transfer, Hurley notes. When your child reaches age 18 or 21, depending on your state, the account will still become the child’s property.

A big break for prepaid tuition plans. A special type of 529 plan offered by 13 states lets you prepay your child’s tuition at a state college or university. You pay what tuition costs now, and the state promises to pick up the much higher tab when your child matriculates. These plans come with several restrictions and may not be the best way to save for college. But one of their biggest shortcomings, before the Deficit Reduction Act, involved financial aid. Any award had to be reduced dollar for dollar by a payment from a prepaid plan. Now, such money is treated like any other 529 asset, as a parental resource to be assessed at a maximum of 5.64%.

More predictable loan costs. Of course, if your income is high, your child isn’t likely to qualify for need-based aid no matter where you hold your savings. That could mean taking a loan. The interest rate on Stafford loans, for students, is permanently fixed at 6.8%, while PLUS loans, for parents, have a fixed rate of 8.5%. Meanwhile, loan origination fees, which had been as high as 4% of the borrowed amount, are being phased out by 2010.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.